Fixed Income Conversation Corner: Private Credit edition with Dan Oneglia (Blackstone) and Leslie Falconio (UBS CIO)

Good day UBS, Dan Cassidy here. As we have been highlighting, we are back now with the next installment of our ongoing Fixed Income Conversation Corner podcast series here on the UBS Market Moves podcast channel. Joining us today from our partners at Blackstone, glad to welcome Dan O'Neillia, Global CIO of Liquid Credit Strategies and CEO and Co-CIO of the Blackstone Multi-Asset Credit and Income Fund.

We're also joined today, as always, by Leslie Falconeo, Head of Taxable Fixed Income Strategy for the Americas from the UBS Chief Investment Office. So with that, Dan, Leslie, thank you both for dropping by the podcast. Leslie, let me now pass it over to you to lead today's conversation with Dan.

Dan, thanks so much. And Dan, thanks to you. I really, I really appreciate you coming on.

This is such a great time to have Blackstone on and to talk about what's going on in the credit world, particularly as it relates to, you know, private credits. This is a very timely conversation, particularly given the fact that it's in front of the Fed. You know, we have a bit of a shift in terms of, you know, those path projections about what the actual Fed may actually do over the next 6 to 12 months.

So thank you so much for coming on. I really appreciate it. Oh, happy to be here with you guys.

I would say some of the, you know, media or things around private credit has been a little bit dormant lately, right, doesn't necessarily mean that it's dead, but we know that the first couple of months, particularly in February, you know, there was a lot of, you know, headline, negative headlines, a lot of, you know, even, you know, particularly and potentially a lot of negative, foreign-looking information or data. So I just want to get a sense from you about when we think about this noise or, you know, headline risk that we're seeing about, you know, private credit, like when this happens, right, what's sort of the most important thing to focus on for clients? Well, yeah, it's a great question, Leslie, and I think, you know, what we try to do when we see this kind of noise, when we see this kind of, you know, headline risk is step back and look at the facts and look at the fundamentals and really just try to dig back in to understand, are we missing something?

Is there something out there that we should be paying more attention to and, you know, just reassessing the landscape, right? I mean, I think that's the best thing that you can probably do in that environment. So when we step back and we kind of get away from the headlines, what are we seeing, right?

What we're seeing is credit metrics that are pretty resilient. So from an economic backdrop perspective, I would say it's strong. That's our view.

Businesses that we invest in in private credit are growing. They're growing revenue. They're growing EBITDA.

That means that there are improving metrics on things like leverage and interest coverage ratios. You know, there's an enormous amount of capital being spent, sort of a generational amount of CapEx being spent here in the U.S. That has a trickle-down effect that is somebody else's revenue, and that supports the backdrop in a lot of ways across the economy right now.

So I think the first thing we look at is those fundamentals at the underlying business level, and they seem pretty strong to us or pretty good to us. I think the second place that we're focused on is, you know, our place in the capital structure as direct lenders, right, as senior secured direct lenders. We're first lien in the capital structure.

We have the benefit of that absolute priority waterfall. And on top of that, you have significant equity cushion below you, right? We're primarily funding sponsor-backed deals.

These sponsors have injected equity or subordinated capital below us. Our loan-to-values are typically, you know, around 40 to 45 to 50 percent in senior secured direct lending. And so recognizing that you're in that good place from a capital structure perspective, I think, is really important as well to just reset and think through.

A lot of people have been focused on, you know, non-traded BDCs and the fact that there's a lot of individual or retail investors there. And that is true of that specific part of the asset class, but private credit more broadly is still largely an institutional asset class, like 90 plus percent institutional investors. And again, they tend to be, you know, a source of more stability.

The funds that they're invested in, broadly speaking, are unlevered. And, you know, they're going to be there for the longer haul, I think, in a way, right? This is a big allocation for them that's meant to be there for quite a period of time.

And so when we look at all of that, we feel pretty good about the sort of fundamentals and the backdrop that's, you know, different than, you know, quite different than what you see in the headlines. You know, I think, Dan, you bring up a really great point, particularly for a lot of our listeners because, you know, the retail component of that, as you pointed out, is maybe, say, 15 percent-ish, maybe 20 percent. But it's mostly, you know, that institutional type, that long-term hold that aren't those that, you know, get concerned about, say, running for the exit.

And why I want to bring this up is that, you know, during, you know, especially in February when we had such a spotlight on, you know, some of this underperformance and these projection redemptions, you know, it's very natural for, you know, investors or clients to go right to the great financial crisis, right? Or think that these risks that you might see on the private credit side might actually end up being, you know, systemic. So when you get those kind of questions, you know, could this be the next, you know, financial crisis or how does this differ from 2008, you know, how do you normally respond to those?

Well, it's, I mean, again, it's a little bewildering to us that people are making that comparison because I think the differences between, you know, the private credit asset class and really the subprime market that drove a lot of the seeds of the GFC, they're just very different in nature, generally speaking. So maybe to sort of take a step back, if you go back to the sort of years leading up to 2008, a lot of the subprime borrowing that was getting done was very, very levered. You're talking about 90% to 100% loan to values against these housing assets.

And the borrowers themselves were not highly vetted, right? Many times there was no confirmation of income, of overall wealth, of their ability to actually service that debt. At the same time, the people that were providing the financing in the pre-GFC days were also quite levered themselves.

So we had, you know, banks that were lending to subprime borrowers that themselves were 25 or 30 times levered. And they were the primary source of their financing or a big source of their financing were deposits and were repo financing to, you know, liabilities that are quite fickle often and can, you know, run to the exits relatively quickly. So you had mismatch of asset duration and liability duration.

You had very, very levered borrowers on both sides of the equation. And that is what the makings of a financial crisis I think can be, right? Those two things when they meet with stress are probably not the best.

And so when you contrast that to today's environment and what we're seeing in private credit, I just think it looks very different. You know, we at Blackstone think it looks very different. First of all, if you think about the borrower, we just talked about it.

You know, we're lending to companies that are backed by sponsors. These are real businesses. They're businesses that are generating cash flow every single day.

They have customers. They have real management teams and they've been vetted by the sponsor that's buying them. The sponsor obviously sees significant upside in owning this business.

And they're putting a lot of capital in behind you. So I think, as I said earlier, in most cases as a lender here, we're 40 to 50% loan to value. So sort of one part equity and one part debt versus maybe nine parts and one part in the subprime GFC days.

Further, as we talked about a minute ago, the leverage in the vehicles that hold private credit is very, very low if it exists at all. So we talked about institutional investors being like 90 plus percent of the market. They're usually in drawdown funds or some form of SMA or fund of one structure where they're either lightly levered or have no leverage.

In the BDC world, which is also obviously a buyer of private credit, we're seeing leverage that's usually less than one times. So 0.7, 0.8 in sort of the non-traded BDC universe. And so, again, you've got much lower leverage.

You've got much more institutional-oriented ownership. You've got a borrower that is backed by a sponsor with significant subordinated capital. Those don't seem to us to be the seeds of a major crisis, I think.

And so it does feel like, as you talked about, like some of that has come out of the market over the last month or two as people have sort of stepped back and thought about it. And we've had some regulators opine on the fact that they don't see this as a systemic risk either. Obviously we're always watching for excess in the financial system and trying to be careful about that.

But we don't really see it today in private credit. I totally agree. I agree 100% with everything that you said, and this is not – I mean, we've been emphasizing to your same points about how to build some more leverage and that this is not – regardless of what certain media headlines that might try to indicate, we're heading to a large financial headwind, if you will.

We don't view it like that. We definitely don't view it as a 2008 scenario, even remotely close. But I have to say, Dan, CIO, when we entered into 2026, our outlook was fairly – I would call it fairly consensus in regards to our outlook for the Fed.

I mean, we expected the Fed to conduct maybe two non-recessionary type of cuts and for growth to stay above trend, maybe slow a little bit. But we had a pretty strong economy overall, but there were going to be cuts. And with that, we sort of, I would say, indicated to our private credit investors that the biggest thing at the end of 2026 was managing your expectation on returns, meaning that the days of the 13% that you saw in terms of carrier yield and returns or 10%, as we head into spreads that were already tight, you had to sort of mitigate that and lower your expectations to not think you're going to get these 13%.

So when we sit here now and I look at where spreads are in the public market, spreads are very tight in high yield. They've come in for loans as well. Private software is still very wide in that component.

But spreads have come in, yields are still pretty healthy, and even though with all the negative headlines, we haven't really seen this major blowout in terms of the direct lending side. So I have to ask you, when you look at that and we say a Fed is maybe high for longer in the short term, but in our view will cut, how do you sort of relay to investors, to clients, why should they have a private credit in their portfolio today? Look, I think it's a great question and part of it has to do with the fact that the asset class itself has grown a lot over the last decade.

If you think about the market to fund effectively sponsor buyouts, you have three big markets. You have the high yield market which you touched on, it's about a third of the market. You got the leveraged loan or the broadly syndicated loan market which is about a third of the market.

And you have private credit today which is about a third of the market. And we look at them as sort of concentric circles and deals are going to kind of go back and forth between all of them. And there's a reason that this market developed in the way it did because it offers benefits to both the borrower and to the lender.

So the borrower gets speed, certainty of execution, and some flexibility that they might not be able to get from the syndicated markets where you're distributing to a broad swath of investors. Here it's a more bilateral in the private credit world. It's a more bilateral negotiated bespoke arrangement.

And sponsors have found that that's quite beneficial to them for all of those reasons I just mentioned. From the lender side, what lenders have realized is that they can earn a couple hundred basis points often of excess spread and get a better structure, a better document structure, better protections. And in exchange, they're giving up a bit of liquidity.

And if you're structured well, then you're going to over time compound that excess spread into much higher returns on a portion of your portfolio. So when we think about private credit, we really look at it as not so much a tactical allocation but as a core holding that doesn't have to replace all of your credit exposure, doesn't have to replace all of your fixed income exposure. But it should be something as this asset class continues to grow and deepen and develop that investors should have as part of their portfolio.

And if you look back over time, that compounding impact of excess spread coupled with low default rates, low losses given default, and all of that equals a really good outcome for investors' portfolios. So I think that's really how we think about it when we talk about private credit as really a through cycle holding for portfolios. I can't agree any more in terms of the – and what you said there as well, it's a longer term hold.

And the reason why – and it's meant to be a long term. This is not to be traded on a quarterly basis. This isn't something that you see necessarily in the public market.

And there are certain benefits of having that longer term hold in terms of compounded income as you mentioned. And that sort of brings me to my next question, which has to do with a lot of the headlines, particularly what we saw. We saw it in February.

We're seeing it again now because we're going to – we had the end of the first quarter and second quarter is coming up. It's a lot of these sort of when you think about either evergreen funds have grown really quickly and the kind of capping mechanism that they have are having investors, particularly on say the retail side, understand liquidity in these investments. I mean there are certain nomenclatures that are used that I don't particularly care for like semi-liquid.

But if you could just go through your thoughts on that and I think the most important thing that you had mentioned is that these are meant for a longer term hold. So if you could just – what are your thoughts on evergreen and some of these caps and just the – some of the negative headlines that we've seen say by the media in terms of liquidity and redemption. Yeah.

I mean look, I think as we've talked about, when we think about the reason why we're seeing this come up and why there's been higher redemptions, obviously it's been driven by a lot of the headline risk that we've talked about and the fundamentals wouldn't necessarily say that there's a significant issue here and so what else could it be? It's probably a lot of some of the fear that's out there from headlines. And the structures themselves, the capping mechanism, most of the non-traded BDC structures that we're talking about typically have sort of a 5% quarterly cap on liquidity.

And we view that very much as a feature and not a flaw of the structure. It's a way to protect investors from themselves. It's very easy if somebody yells that your house is on fire to run out of the house.

You're not going to like wait around and see if that's actually true. I think these features are there to protect long term investors from that fear mongering that can go on. So that's a big part of it from our perspective.

I think that you make a really great point that hopefully it's understood by the people that are investing in these products that there is limited liquidity, that it's not always going to be available to you. And that's part of the tradeoff I was talking about earlier for getting excess spread is that there's going to be a little bit of a liquidity tradeoff that you have to make. And that's why when you think about your portfolio construction, it should be a piece.

It doesn't necessarily need to be a hugely concentrated piece. There's also the idea of liquidity at the underlying non-traded BDC level. And there I think there's also a lot of cushion for investors to be focused on and to get comfort around.

So first, if you think about the sources of liquidity, there's obviously cash that some of these vehicles will hold. There's traded securities which are often broadly syndicated loans that they'll hold that they can sell down to meet redemptions. And then there's borrowing capacity.

There's ABLs that they have that all these vehicles have, asset-based lending facilities such as ABL and revolving credit facilities that they have that they can tap into. And most of them, as we talked about, are very under-levered. And so there's capacity there to borrow as needed to a point to kind of support liquidity needs in the short run.

And when we add all those things up, we get to something like seven plus quarters right now of liquidity available from those sources. And that's before you kind of get into repayments. These loans that are made, they have maturities.

And we've seen several billion dollars come back to us over the last 12 months in repayments at the firm. We expect we'll see more because the sponsors that own these companies, they're going to look to monetize this debt at some point and monetize their asset, the equity, through a sale, through an IPO. Maybe they just look to refinance for a cheaper cost of capital because the business is performing well.

And so all of those things are out there to, again, support liquidity in these vehicles above and beyond that sort of seven or so quarters that I talked about. So I think it's something people have to focus on because it's in the headlines. I think it's something that is a concern.

But when you dig in under the surface again and you look at the facts and the fundamentals, it's actually pretty well-supported, these structures. When we think about, and this has been a topic of conversation, not just for the private but also the public market, and even taking us off for a moment because I know we're going to get to that a bit later in the discussion, but let's talk about things such as defaults and not only defaults, but obviously the recovery is just as important, if not more important, in my opinion. Everyone's talking about the normalization of these kinds of defaults because you essentially were going from incredibly low levels.

But you do have varying degrees of, and everyone calculates defaults in a different way, right? We know that. Whether, as you know, as rating agencies calculate them differently, as sell-side institutions calculate them differently.

So there's always a different way to calculate this, which sometimes can be a bit confusing. But how do you see, when they talk about defaults, the normalization, how do you see this trend in the market, in the credit market going forward? Let's just start with framing it a little bit.

I think long-term default rates in the high-yield and the broadly syndicated loan market have been around 3 or 3.5% over the last 25 years or so, right? And I don't know that there's a reason to think that the private credit market through time is going to look hugely different from that, right? Because at the end of the day, you're making loans to high-yield borrowers and high-yield companies.

Private credit has benefited, I think, over the last several years from much lower default rates. And maybe that has to do with better underwriting. Maybe that has to do with the fact that it's a bespoke deal that you're cutting with the sponsor as opposed to a broadly syndicated market where whatever clears the market clears the market.

And so the normalization, I think, will come as you get longer into any credit cycle, right? So the good companies, the best performing companies are going to refinance themselves along the way or they're going to get sold as I talked about a minute ago. In credit investing, there's always a tale of performers that struggle a little bit more, right?

It's kind of like adverse selection as you get further into a credit cycle. So that's the normalization I think people are focused on is that there's going to be a period of time where you step back up from sort of 50 basis point default rates to something closer to 2% or 3% the long term averages. Right now, the high yield market is, I think, around 2% on an LTM basis.

The leverage loan market is 2.5%. But the private credit market still sits well below that. And again, we'll probably trend upwards is our view over the coming months.

But you make a really great point, Leslie, which is that it's not really about the default. It's about what happens post the default. And so the default in and of itself isn't necessarily a bad thing.

You need to focus on is the recovery, which you pointed out, or the loss given default. And here, again, I think structure really matters. And I think we could see much, much better recoveries when there are defaults in the private credit market because of the quality of the documentation that you get upfront.

We've seen over the last 10, 15 years in liquid credit markets significant deterioration in document protections. It's not just giving up a maintenance covenant. It's about the investment baskets.

It's about the ability to layer debt on top of you. And you don't see the same things in your typical private credit document at all. And so I do think you'll see this trend maybe back to normalization from a default perspective.

But I think you're going to see very different outcomes from a recovery perspective in the private credit markets. And in particular, this is where manager selection is so important. Do you have the ability to take over these businesses, to run them, to add value, to enhance performance, to work with the management teams?

And I think certain managers, some managers will have much better capabilities at that than others. So when we think about that, and just to extend on that conversation and sort of address what the elephant in the room has been for the past couple of months, we think about AI and software. And this has been, and we know, compared to things like high yield, obviously, and even loans for that matter, private credit is much more software exposure.

And it's been such a spotlight in terms of the varying degree of default projections, but also the varying degree of recovery as well. And we know there's, and I'm sure you'll get into this, the different vintages that are a bit more red flag than others, and potential decline in underwriting standards at certain periods of time. But how do you address to your clients, because it is such a focal point, those risks, like the risks of software, how would, it's going to be a show-me market, right, because it could project as much as they want, but you're really not going to know until you see it.

But how do you mitigate or try and explain to investors that see all these headlines concerned about software, concerned about some of these all of a sudden becoming a bit obsolete sooner than what was expected? I'm just curious how you relay that information to clients. Yeah, it's very topical, obviously, and I think it's something that you have to address across more industries than even software.

I think AI is going to have an impact on a broader set of sectors, but obviously software is in the crosshairs immediately and right now, and that's where people are focused. I think maybe, again, taking a step back and thinking about what were the things that attracted investors to software to begin with, and I think it starts with very solid, often long-term contracted cash flows with low capital intensity, so high free cash flow conversion. And if you think about lending against those types of businesses, they can be quite attractive, obviously, for those reasons.

The risk is that AI comes in and disrupts that sequence. Does it steal that cash flow away from you in some form or fashion? And so I think there you have to look at, okay, what is it that is easy for AI to attack and what is harder for AI to attack from a software perspective?

And we have been thinking about the impact of software on our portfolios for quite a long time. It's not something that we just started thinking about in January when Cloud Code came out. And so we've tried to focus a lot of our software investing in a couple of different ways in a couple of different places.

So first of all, we focused on the subsectors within software that we believe are going to be much more resilient to an easy AI solution. So if you think about enterprise resource software businesses, if you think about the deeply vertically integrated software businesses with large historical data lakes or data moats, very embedded in the workflows of the companies that they sell to, if you think about cybersecurity is another one. And if you think about sort of the regulatory angle that also comes to fruition in software, a lot of companies rely on their software to meet the needs from a regulatory perspective that they have for just running their business.

And those are things, all of those components make switching away from that software solution that you have embedded in your business much more difficult for a CTO or a CFO or even a CEO to turn to an AI alternative rather than maybe the embedded long-term software company that they've been working with. So I think this transition may not happen as fast as the market is discounting it to happen. And likewise, I think that a lot of these software businesses are going to be AI winners.

They're actually going to be able to implement AI tools into their existing workflows and leverage the benefit of the information that they have, the moat that they have, to actually make themselves even more valuable to their customers. One of the things we've also focused on is bigger companies, bigger software businesses tend to be able to have the tools and the ability to move more quickly, to embed AI, have the know-how from management to embed AI in their workflows, again, to better insulate them from this threat. And so I think that's, again, at the end of the day, it's all about bottom-up credit selection.

And I think if you've built your portfolio to focus on these characteristics, you're going to have much better likelihood of positive outcomes over the next, whatever it is, five, seven, ten years than otherwise. That's not to say that we have our head in the sand. I think you have to be cognizant of the fact that there is going to be disruption.

And then we go back to like, okay, where do we sit in the capital structure? And what does that cash stream really look like, right? That contracted cash flow that these businesses have.

And we still believe that there's a lot of value in that that's going to support a lot of our credit positioning in the coming years. Yeah. I think that's, and it's true, Dan, as well.

I mean, one of the biggest performance drivers that we emphasize, it's just the manager selection as a whole. Like, our expectation was coming into the year, you'd see divergence and total return amongst managers. But when you've had these kind of negative headlines that we had, everyone was sort of taking that hit.

And now, as the market calms down, we hope that that sort of manager selection, the divergence and total return among managers, for those that, like you looked yourself, had mentioned, go for those higher type loans, bigger businesses, we think is one of the important drivers. But I do want to end on a positive note, in the sense that where you see these opportunities in private credit. Now, we've had a bit of recovery from what we saw back in January, February.

There's no question. But volatility creates opportunity. And we don't know whether or not, once we have the crisis in the Middle East, not take a bad seat, but sort of move back a little bit, whether or not private credit will come up in terms of the main headline.

But for right now, where do you see, for investors, opportunities in private credit? Yeah. So I think it's a great question, and maybe speaking to the volatility side of it, there's no doubt that the experience over the last quarter or two and what we've seen in the headlines is having an impact on capital formation in our space.

Obviously, we're seeing heightened redemption still coming through in some of the second quarter here. And in that, there's probably some opportunity, right? You are going to have the pendulum swing back in favor of the lender, perhaps, versus the borrower in private credit and corporate private credit.

And you could see spreads widen. You could see less competition and, therefore, a better opportunity to deploy capital in the quarters ahead as a result of this disruption that we're going through. Some of that is obviously dependent on the M&A cycle and on sponsors starting to play offense again.

And I think you touched on it. That's probably been dampened a little bit from the sort of expectations that we had coming into the year by the war in Iran and the uncertainty around interest rates and Fed policy that you touched on earlier. So we need to see that kick back into gear in a much more constructive way, I think, to drive some of that.

But certainly, shakeouts like this and volatility like this can be good opportunities to sort of deploy capital and lean in on the private credit side, I think, or in any market, really. I think the other opportunity that we're seeing in private credit is just this expansion beyond corporate private credit into sort of real assets. And for all the reasons I talked about earlier, that borrowers in the sponsor community have found the benefits of private credit, that speed, that certainty of execution, that flexibility of structure, you know, borrowers in other markets are seeing that as well.

And when we think about the secular growth story that's out there that's driven by sort of the energy infrastructure build-out, the AI infrastructure build-out, there's enormous opportunity to lend against hard assets with contractual cash flows in the market right now. And I think that investors are going to start to take advantage of that opportunity in private credit as well. We're already doing it at Blackstone in a big way.

And I think you'll see this expansion, which McKinsey, I think, still estimates. I think they just put out a new private credit piece that talked about this market TAM being something like $30 trillion. And if you think about where we are today, around $2 trillion.

There's a lot of room to run if things, you know, unfold as they predict. And so that's another place where I think you're going to see private credit investors like ourselves, you know, play some offense. Okay.

Well, great. Well, listen, Dan, I want to thank you so much for joining me on this podcast. It really was very informative and it was great speaking with you and for you to share how Blackstone's doing, some of how you might set yourself apart and your outlook on credit and private credit.

So thank you so much for coming on. I really appreciate it. Perfect.

Well, thank you, Leslie. I appreciate it and appreciate the opportunity to chat with you guys. Thank you for tuning in.

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